Taper Tantrum

What is the Taper Tantrum

Taper tantrum is the term used for the 2013 surge in U.S. Treasury yields, which resulted from the Federal Reserve's use of tapering to gradually reduce the amount of money it was feeding into the economy. The taper tantrum ensued when investors panicked in reaction to news of this tapering and drew their money rapidly out of the bond market, which drastically increased bond yields.

BREAKING DOWN Taper Tantrum

When the economy needs a boost or is on the verge of crashing, the Federal Reserve feeds money into the system through quantitative easing (QE), which gives everyone extra money. This allows people to spend more money, which boosts businesses, which in turn boosts manufacturers, and the economy as a whole experiences a boost. This is commonly known as a stimulus package.

QE is only intended to be a short-term solution. The danger comes when the Federal Reserve either feeds the economy for too long, which lessens the value of the dollar, or cuts it off abruptly, which causes mass panic. Tapering is a system of slowly reducing the amount of money the Fed puts into the economy, which, in theory, gradually reduces the economy's reliance on that money. However, if the public hears that the Fed is planning to engage in tapering, panic can still ensue; that panic is called a taper tantrum.

What Caused the 2013 Taper Tantrum?

Tapering can backfire and causes a taper tantrum when investors hear about the Federal Reserve's reduction of money into the economy and view it as an indication that the market will be unstable without these extra funds. In 2013, Federal Reserve Chairman Ben Bernanke announced that the Fed would no longer be purchasing bonds, and mass global panic ensued. Bond yields drastically increased. However, once investors realized that there was no reason to panic, the market leveled out again.

But Why Didn’t the Stock Market Fall During the Taper Tantrum?

Many pundits believed that the stock market would plummet when the Fed announced it would scale down its bond-buying program in 2013. Instead, the Dow Jones Industrial Average (DJIA) made gains following the first signs of the the QE program, even though previous warnings resulted in declines in mid-2013. Some of the reasons the stock market didn’t necessarily follow the warnings include that there was overall mood in the Fed’s faith in recovery. Secondly, there was a sense that the tapering would reduce uncertainty in the economy, eliminating shock while tightening the conditions slowly. Furthermore, much of the sell-off already happened, and more people were buying into the news of the tapering by the government.

Indications of Taper Tantrums in the Future

As the economy recovers from the Great Recession, there has been talk of another potential taper tantrum. The Federal Reserve has started to raise interest rates, which means people will spend more money on loans and investors will speculate on whether the economy is moving toward another recession. There is controversy over whether a taper tantrum is expected, as experts are divided on the issue. Regardless, the market is expected to react negatively, and bond yields are expected to increase, even if a full-blown taper tantrum doesn't occur.

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